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Warren Mosler is a self-taught economist, hedge fund creator, automotive and marine engineer, and self-made billionaire with a commitment to the public good who’s “gift is transparent lucidity” (more here). His free book, Seven Innocent Frauds of Economic Policy, exposes the widely-held myths about how the economy works in a post gold-standard world.

The fact that almost no one actually understands how the government and its central bank operate in a fiat monetary system, makes it imperative that we and our subscribers are cognizant of reality. With the level of instantaneous transmission of information available across the globe, it is a rare opportunity in deed when we can possess knowledge and information that is not widely known, understood, or believed. Our subscribers are free to read the little book at their leisure, but we have decided to summarize Mosler’s debunking of these myths because we believe it is essential knowledge for success in the market.

Myth #1

The government must raise funds through taxation or borrowing in order to spend. In other words, government spending is limited by its ability to tax or borrow.

The Truth

Federal government spending is in no case operationally constrained by revenues, meaning that there is no “solvency risk.” In other words, the federal government can always make any and all payments in its own currency, no matter how large the deficit is, or how few taxes it collects.

Unlike households and local governments, the Federal Government can create as much currency as it needs. The government (Federal, not local government) does not need and does not use your tax dollars to buy anything. It pays for what it buys — social security, interest on the national debt, defence, etc. — through spreadsheet adjustments at the Central Bank (Federal Reserve Bank).

When someone receives their $2000 Social Security payment, it appears as a deposit in their checking account. That deposit, originated when the Treasury marked up an account at the Federal Reserve that belongs to the regional bank where the recipient has their checking account. All it took was a keystroke at the Treasury, and $2000 came into existence in the recipient’s account. No taxes required.

Why do we have taxes then if the government doesn’t use them? Because:

Taxes create an ongoing need in the economy to get dollars, and therefore an ongoing need for people to sell their goods and services and labor to get dollars. With tax liabilities in place, the government can buy things with its otherwise-worthless dollars, because someone needs the dollars to pay taxes.

Myth #2

With government deficits, we are leaving our debt burden to our children.

The Truth

Collectively, in real terms, there is no such burden possible. Debt or no debt, our children get to consume whatever they can produce.

WWII resulted in huge deficit spending (“debt”) that created dollars held as Treasuries securities in what is essentially savings accounts at the Fed. When these Treasury securities come due, and the “debt” has to be paid back, all that happens is that the Fed shifts the dollar balances from the savings accounts (Treasury securities) to the appropriate checking accounts. That does not create any problems at all. Those dollars were created when the government spent them, and all that happens is they move in and out of the appropriate accounts.

We are not sending real goods and services back in time to 1945 to pay off the lingering debt from World War II, and we are not sending any goods and services back in time to pay off the debt of 2008 either. In our children’s future, just like today, whoever is alive will be able to go to work and produce and consume their real output of goods and services, no matter how many U.S. Treasury securities are outstanding. [Note: However, raising rates requires the Treasury to increase its currency-creation to pay interest on Treasuries which further increases the private-sector surplus.]

Myth #3

Federal Government budget deficits take away savings.

The Truth

Federal Government budget deficits ADD to savings.

This third deadly myth is alive and well at the very highest levels. A recent example:

I remain concerned about the longer-term effects of high and rising federal debt, which can restrain private investment and, in turn, reduce productivity and overall economic growth. The longer-run vitality of the U.S. economy would benefit from efforts to address these issues.

That was Jerome Powell, the current Chairman of the Federal Reserve, addressing Congress on July 10, 2019. Considering who’s mouth that statement came out of, it is a most disconcerting misunderstanding, to put it politely.

In plain language, government deficits ADD to our savings, penny-for-penny. Any Government deficit that is in $US, exactly EQUALS the the total net increase in the holdings ($U.S. financial assets) of the rest of us — called the “non-government”, or private sector. It is basic national income accounting!

How many times have we heard this?: “Deficit spending means the government borrows from one person and gives it to another, so nothing new is added -it’s just a shift of money from one person to another.” In other words, they are telling us that deficits don’t add to our savings. Here is proof that they couldn’t be more wrong:

1. Start with the government selling $100 billion in Treasury securities.

2. When the buyers of these securities pay for them, their checking accounts at the Fed are reduced by $100 billion to make the payment, and their savings accounts (Treasury note) is credited $100 billion. They have shifted $100 billion from a checking account to a savings account.

3. Now the Treasury spends $100 billion on the usual things government spends its money on (military, social security, medicaid …).

4. This Treasury spending adds back $100 billion to the checking accounts belonging to the private sector.

5. The non-government sector now has its $100 billion of checking accounts back and it has the $100 billion of new Treasury securities.

GOVERNMENT DEFICIT SPENDING = PRIVATE SECTOR SURPLUS

Myth #4

Social Security is broken.

The Truth

Federal Government Checks Don’t Bounce.

All members of congress believe that Social Security is broken. It is not.

As already pointed out, the government never has or doesn’t have any of its own money (unlike you and I). It simply spends by changing numbers up and down in Fed bank accounts. This includes Social Security. Regardless of what the numbers are in the Social Security Trust Fund account, the government will always be able to meet all Social Security payments in a timely manner. To make Social Security payments, all the government has to do is change numbers up in the beneficiary’s accounts, and then change numbers down in the trust fund accounts to keep track of what it did. If the trust fund number goes negative, so be it; It is nothing more than an accounting ledger.

But what about in 30 years when there will be a lot more retirees than workers to pay into the Fund? Let’s exaggerate to make a point. Image that some time in the future, there are 300 million retirees and only one person left working. That lone worker is going to be awfully busy growing all the food, building and maintaining all the buildings, taking care of all the medical needs, producing all the TV shows, and so on. Obviously, making sure that the 300 million retirees have enough money to pay this person is not going to be the problem. The real problem is not about money. It is about production; real-resources.

The problem needing a solution is how to make sure that the guy working is smart enough, skilled enough, has enough capital goods and technology to get everything done, or else the retirees are in serious trouble. If the remaining workers aren’t sufficiently productive, there will be a shortage of goods and services. More money to spend would only serve to drive up prices and inflation. Again, money is not the issue. The mainstream myth that “government needs to cut spending or increase taxes today, to accumulate the funds for tomorrow’s expenditures”, is a ridiculous concept which works to undermine our well-being and that of the next generation. The only thing we can do for our descendants that far into the future, is to do our best to make sure they have the knowledge and technology to help them meet their future demands. How exactly does limiting education spending help the situation? Education is the one thing that can be done to help our children 50 years down the road maintain a good standard of living .

Myth #5

The trade deficit is an unsustainable imbalance that takes away jobs and output.

The Truth

Imports are real benefits and exports are real costs. Trade deficits directly improve our standard of living. Jobs are lost because taxes are too high for a given level of government spending, not because of imports.

In economics, it is better to receive than it is to give.

Here is madness:

since the end of WWII, Japan has been sending us about 2 million cars per year, and we have been sending them little or nothing. They think that this means they are winning the “trade war,” and we think it means that we are losing it.

That, is madness!

We have the cars we want and they have the bank statement from the Fed showing which account their dollars are in. Dollars that the Treasury keyboarded into existence at essentially no cost.

The same situation exists with China; China sends us real goods and services, and we give them a bank statement from the Fed. Why would we want to end this arrangement? If not madness, then a complete misunderstanding of our monetary system by our leaders. {Trump’s tariffs on the US’s closest trading partners seems like peak madness}.

Let’s look at an example of a typical transaction. Assume you live in the U.S. and decide to buy a car made in China. You go to a U.S. bank, get accepted for a loan and spend the funds on the car. You exchanged the borrowed funds for the car, the Chinese car company has a deposit in the bank and the bank has a loan to you and a deposit belonging to the Chinese car company on their books. First, all parties are “happy.” You would rather have the car than the funds, or you would not have bought it, so you are happy. The Chinese car company would rather have the funds than the car, or they would not have sold it, so they are happy. The bank wants loans and deposits, or it wouldn’t have made the loan, so it’s happy.

Everyone has what they want and are happy. There is no “imbalance”. And when it comes to a dependence on foreign capital, there isn’t any. It is all domestic credit creation — the bank loan funded the Chinese desire to hold $US in a US bank as savings. There is no foreign capital involved anywhere in the process.

All we have to do is keep American spending power high enough to be able to buy BOTH what foreigners want to sell us AND all the goods and services that we can produce ourselves at full employment levels. Yes, jobs may be lost in one or more industries. But with the right fiscal policy, there will always be sufficient domestic spending power to be able to employ those willing and able to work, producing other goods and services for our private and public consumption.

The key point here is “ the right fiscal policy”.

Myth #6

We need savings to provide the funds for investment.

The Truth

Investment adds to savings.

“The paradox of thrift”:

In our economy, spending must equal all income, including profits, for the output of the economy to get sold.

If anyone attempts to save by spending less than his income, at least one other person must make up for that by spending more than his own income, or else the output of the economy won’t get sold.

So the paradox is, “decisions to save by not spending income result in less income and no new net savings.” To spend more than one’s income by going into debt cause incomes to rise and can drive real investment and savings.

Consider this extreme example to make the point. Suppose everyone ordered a new pluggable hybrid car from our domestic auto industry. Because the industry can’t currently produce that many cars, they would hire us, and borrow to pay us to first build the new factories to meet the new demand. That means we’d all be working on new plants and equipment — capital goods — and getting paid. But there would not yet be anything to buy, so we would necessarily be “saving” our money for the day the new cars roll off the new assembly lines. The decision to spend on new cars in this case results in less spending and more savings. And funds spent on the production of the capital goods, which constitute real investment, leads to an equal amount of savings.

When investment falls, usually because of low spending, the government in their infinite wisdom decide “there needs to be more savings so there will be more money for investment”. And this they accomplish via tax-differed savings incentives such as pension funds, IRA’s and a host of tax-advantaged institutions that accumulate vast reserves on a tax-advantaged basis. All these incentives do is remove spending power (aggregate demand) which keeps us from buying our output, slows the economy and fuels private sector credit expansion just to get back to even.

It’s all backwards!

Myth #7

It’s a bad thing that higher deficits today mean higher taxes tomorrow.

The Truth

It’s a good thing!

Why does the government tax? Not in order to get money to spend, because it creates money when it spends and, therefore, doesn’t need our money. The government taxes as a way to create demand for money at times when unemployment is low and there is excess spending power relative to the supply of goods and services (inflation). Taxes, along with reduced deficit spending help counteract inflation — which is a shortage of supply. If there are no shortages, then there is no inflation, and there is no need to increase taxes or reduce the government’s deficit spending.

Until recently, low unemployment and inflation went hand-in-hand, but since the GFC this relationship has not appeared; government deficits have produced low unemployment without the usual increase in inflation. (We’ll leave the reasons for this disconnect for another time.) So when everyone is warning of the dire consequences of “late-cycle” easing, they are using the low unemployment to define late-cycle, and forgetting that there are no shortages and no inflation. The fact that we cannot hold on to even 2% inflation, means we have no need to reduce spending power or to stop deficit spending. {Note: this was written before the COVID supply shock}.

Federal Government Deficits = Private Sector Surpluses

Inflation is the only non-self-imposed limiting factor for government spending, and if government spending is reduced during low-inflation periods, the result is recession.

This ends our series on myth debunking. We leave the last word to the great Randall Wray…

Q: My understanding of domestic government budget surpluses is that they merely destroy the dollars that earlier government spending created. Isn’t it meaningless to suggest that a sovereign government “saves” its own fiat currency?

A: In practical terms, yes. In the United States during the Clinton boom there was a projection that all outstanding US Treasury debt would be retired. This led to a mad rush at the Fed to figure out how the federal government could continue to run surpluses if there were no government IOUs out there to “destroy”. If we ever did get to that point, the only way the private sector could continue to run deficits against the government would be to surrender assets (rather than government IOUs) in payment. You’d have to turn over your car, house, bank account, and children to the government to pay taxes! That is the logical result of a government surplus carried to infinity: government would accumulate infinite claims on the private sector (ANG Traders emphasis added). And, yes, you are correct that sovereign government does not — cannot — “save” its own currency…. Wray, L. Randall. Modern Money Theory

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